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What To Know About Cash-out Auto Refinancing

You’re having trouble paying your bills, and now you need to make an unexpected roof repair on your home, replace your broken refrigerator or pay for a medical emergency. One option some people consider in such circumstances is taking out the equity not in their home, but in their car.

This should be considered in emergency situations only, but cash-out auto refinancing may allow you to borrow potentially thousands of dollars at a relatively low interest rate, if your credit is good. If your credit isn’t good, it may seem like a better alternative to higher-interest personal loans and credit card cash advances. And unlike a home equity loan or line of credit, most of the lenders we checked do not charge fees for cash-out auto refinancing, and the rates may even be lower. Of course, if you don’t have a house, your car might be the biggest asset you own.

But borrowing against your car can be risky, especially if you have no savings and already are having trouble paying bills, which, ironically, might be why you’re interested in this type of loan in the first place. If you don’t make your payments on time, the repo man could drive off with your vehicle, making your financial woes even worse. That’s a big reason why you should consider a cash-out refinance or auto equity loan as one of your last options. Even then, you need to do your homework.

“I wouldn’t want to say it’s never appropriate for anybody. But it should be something that’s approached with a lot of caution,” said Rebecca Borné, senior policy counsel for the nonprofit Center for Responsible Lending.

What is cash-out auto refinancing?

Cash-out or “cash back” auto refinancing and auto equity loans are all ways to borrow against your car and may be available from banks, credit unions or online lenders, but they may work in a couple of different ways:

Example 1: Refinance for a lower interest rate

You have an existing auto loan that you’d like to refinance. Here’s how it works: The institution essentially lends you enough to pay off any existing loan on your car and provide cash back up to a certain percentage of the vehicle’s current value.

Suppose your car is worth $15,000 and you still owe $5,000 on the loan. If the lender’s policy is to provide up to 90% of the car’s value, you’d be eligible for $13,500, minus the $5,000 needed to pay off the original loan. That would leave $8,500 for your wallet. Some lenders might let you borrow more than your equity,  We’ve seen as high 160%.

Pros. Because you’re using your car as collateral, your interest rate could be a lot lower than if you opted for an unsecured personal loan or a cash advance on your credit card. For instance, for customers with an excellent credit, California-based Mocse Federal Credit Union recently was offering an auto equity loan for as low as 4.09% for up to 60 months. In comparison, the credit union’s best rate for an unsecured personal loan was 8.99% and 12.9% for a Visa cash advance.

For those who can’t qualify for an unsecured loan because of bad credit, an auto equity loan may be the only option short of perhaps taking out a payday or car title loan, either of which can have triple digit interest rates.

Another benefit of this type of loan is you might even end up with a lower monthly payment, if you got a bad deal on your original loan because you had bad credit when you bought your car. And there can be few, if any, fees. Mocse Federal Credit Union charges borrowers just a $15 title fee imposed by the California Department of Motor Vehicles, said Jan Tlascala, the credit union’s director of lending. Of course, you would have to meet Mocse’s or any other credit union’s eligibility criteria.

Cons. But if your credit hasn’t improved — or worse, it’s dropped — and you refinance for a higher interest rate, you’re not only essentially starting over with a new car loan, it just got more expensive.

You also risk becoming “upside down” with your car, a situation where you could end up owing more than your vehicle is worth, a problem if the car is stolen or wrecked or you decide you must sell or trade it in. That’s because neither your insurer nor a buyer is likely to give you enough to pay off what you still owe, leaving you with car payments but no car.

There is also the possibility that you might lose your job or become injured, leaving you unable to make the payments.

You can protect against these risks by purchasing GAP insurance, if available, when taking out the loan. But they can add hundreds of dollars to the cost.

Example 2: Borrow against the car you own

You own your car and want to tap its equity. Here’s how that works: Much like the cash-out refinance, the institution lends you the amount that the car is worth or more. Suppose you own your car, which is worth $10,000 according to NADAguides or another industry source such as Kelley Blue Book. If the lender’s policy is to provide up to 125% of the car’s value, you’d be eligible for $12,500 in your pocket, depending on your credit score.

Pros. Again, there’s the potential to borrow money at lower interest rates than other types of loans. Keep in mind, however, that you also might be financing fees, either lender fees or DMV fees or both.

Cons. When you take out a car equity loan, the finance company will have a lien on your vehicle, which gives it the right to repossess it if you miss payments, in some states within just a few days. While that’s the same with any type of auto loan, if you’re already having financial problems, borrowing more money can make things worse, especially if you overestimate your ability to pay. “The worst thing you can do is borrow your way out of a financial crisis,” said Bruce McClary, vice president of communications for the non-profit National Foundation for Credit Counseling.

Where can you find cash-out auto refinancing?

While we found cash-out auto refinancing and auto equity loans at a variety of lenders, credit unions tend to have the lowest rates. But these loans can be expensive. And Borné says some lenders are notoriously bad at making sure borrowers can afford their loans. “It often puts buyers at unreasonable risk of losing their cars,” she said. And some lenders charge very high rates for this kind of loan, despite having a borrower’s car as collateral, she warned.

OneMain Financial, for example, lists its minimum rate at 16.05%, although a representative told LendingTree she has seen some loans issued at 14%. A representative for Mariner Finance said its minimum rate was 19.99%, almost five times the rate at Mocse Federal Credit Union.

Alternatives to borrowing against your car

If you find yourself in an emergency and already are in financial distress, look for alternatives before turning to a car equity loan or any other additional borrowing. Check your budget for areas where you can reduce your monthly expenses. One option may be to ask your bank and other creditors to lower your monthly payments on your loans, credit cards and other borrowing until you can recover financially.

Consolidate credit card debt. Another popular approach is to consolidate credit card debt onto a 0% APR card. But you’ll need a plan to pay it off before the 0% promotional period runs out or you’ll likely end up paying double-digit interest.

Consider traditional auto refinancing. If your existing car loan has a high interest rate, perhaps because you had bad credit when you bought your vehicle, find out if you can refinance the loan at a lower rate, but without requesting cash back, says Borné. Combined with other steps, that might be enough to address your emergency without having to increase your debt and risk. While refinancing, you could reduce your payments even further by extending the length of the loan if absolutely necessary, although that could consume any savings or end up costing you more.

Borrow from friends or family. If you feel you must borrow, maybe a family member can help, or perhaps your employer will provide an advance against your paycheck.

But these options have risks and complications of their own, which is why McClary recommends contacting a nonprofit debt counselor. “Talk to a financial professional who can walk you through all the different options that you may not be able to see because you’re stressed out and panicking,” he said. Some credit unions offer informal financial counseling for members who can’t pay their loans.

Should I take out a cash-out auto refinance loan?

Consider cash-out auto refinancing carefully. Despite what you’ll see on some lender websites, it’s not a good idea to use the equity in your car to pay for a fun vacation, wedding or that leather couch of your dreams, says McClary. But if you have a real financial emergency, such as a medical issue or major car repair, and there’s no better option, cash-out refinancing may be worth considering, says Borné.

Follow these steps:

  • Determine your equity. Start by finding your car’s current value, which you can do on Kelley Blue Book and Edmunds. (The refinancing company may use a somewhat different value, depending on its source.) If you have no outstanding loan, your equity is 100% of that amount. If you have a loan, determine your equity by deducting the loan’s payoff amount, which the original lender can provide.
  • Shop for rates. Borné says credit unions and community banks likely will have the best offers. Tlascala says a good rule of thumb is to expect a rate that’s within a percentage point or so of a standard, used car loan. But if you don’t have a good credit score, your rate could climb to the double digits, making a car equity loan a less attractive option. Unfortunately, some lender websites make you call or actually apply to get even a range of possible rates.
  • Check lender requirements. Also review the eligibility requirements, which can differ by institution. You may not qualify if you have an older vehicle or if it has been driven too many miles. For instance, Mocse Federal Credit Union limits auto equity loans to 2012 and newer models. Also look for the minimum and the maximum loan amounts, which can vary by lender and state, along with any fees. As with their interest rates, not all websites make this information easy to find.
  • Contact lenders. Once you’ve found a few lenders, call or apply to find out how much you might qualify for and the terms, rates and monthly payments. To get exact information, you will likely have to apply, which can temporarily ding your credit score. However, it shouldn’t hurt your credit to apply to multiple lenders any more than it does to apply to one, as long as you do so within a 14-day period. Make sure you understand all the terms and conditions.
  • Verify your ability to pay. Before making a final decision, review your income and expenses to be sure you can afford to make the payments on time and every month. Don’t have a budget? Here’s how to create one, including room for emergencies. Don’t rely on the lender to determine payments for you, warns Borné. Remember, you don’t have to borrow the maximum a lender will give you.

Once you have your loan, come up with a system to ensure you won’t forget your payments. This can involve marking dates on a calendar or setting up alerts on your computer or smartphone. Some lenders provide a rate discount to borrowers who let them automatically withdraw the payments directly from their bank account every month. That can help you avoid paying late or forgetting about a payment altogether, but you must be sure you’ll have enough money in the account every month to cover the withdrawals.

If you miss a payment or know you can’t afford to pay on time, contact the lender immediately to avoid the risk of having your car repossessed. Finally, pay the loan off early if you can. You’ll save money on interest and feel better having your car free and clear.

 

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